Incidental Bequests and the Choice to Self-Insure Late-Life Risks

Lockwood, Lee

doi:10.3386/w20745

Cited by 96 publications

(119 citation statements)

References 60 publications

(131 reference statements)

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“…Both have been identified in the RE literature as crucial elements to generate high old-age asset holdings, cf. De Nardi, French, Jones, DeNardi, and Nardi (2010,2016) and Lockwood (2012). Our results suggest that the estimates in these papers of bequest motives and of precautionary savings motives in light of health risks are upward biased because the underlying RE models do not feature overestimation of old-age objective survival risks.…”

Section: Discussionsupporting

confidence: 48%

“…Following Muth (1961) it has also become standard to express survival beliefs as objective survival probabilities. This standard rational expectations (RE) life-cycle model gives rise to three well established saving puzzles: compared to the RE model, households in the data save too little at young age (undersaving), cf., e.g., Laibson et al (1998) and Bernheim and Rangel (2007), and hold on to their assets until too late in life (oversaving, respectively high old-age asset holdings), cf., e.g., De Nardi et al (2010), Hurd and Rohwedder (2010) and Lockwood (2012). In addition, there is ample empirical evidence for dynamically inconsistent savings behavior, again see Laibson et al (1998) and Bernheim and Rangel (2007).…”

Section: Introductionmentioning

confidence: 99%

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The Impact of Biases in Survival Beliefs on Savings Behavior

2017

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How households consume and save over the life-cycle and how time preferences as well as the time horizon affect these decisions are classical economic questions. According to numerous studies on subjective survival beliefs, young people (younger than about 65) underestimate whereas old (older than about 70) people overestimate their survival chances on average. Another phenomenon is that, on average, young people undersave whereas old people oversave and hold on to their assets too long in life when compared to the optimal behavior under rational survival expectations. Hence, relative to this rational benchmark, the data on actual savings behavior are "puzzling".Intuitively, one would conjecture that the observed age-dependent biases between perceived and objective survival chances are an important explanation for these saving puzzles. The reason is that individuals who do not expect to live for long will consume in the present rather than save for the future to the effect that underestimation of survival chances at young age should give rise to undersaving early in life. Conversely, overestimation of survival chances at an old age should lead to oversaving later in life, so that individuals also hold on to their assets until too late in life.The main objective of our paper is to develop an economic theory based on a life-cycle model with biased survival beliefs to investigate whether this conjecture is correct. We show that biased beliefs may, but need not necessarily, resolve the saving puzzles. While overestimation of survival beliefs in old-age induces households to save more than they would under rational survival beliefs, this oversaving must be sufficiently pronounced so that also the old-age stock of asset holdings exceeds the respective asset holdings under rational expectations. At the same time, with forward looking behavior, this overestimation should not be too pronounced because otherwise the optimizing households would anticipate this overestimation at old-age and rather undersave at a young age.Electronic copy available at: https://ssrn.com/abstract=2943885 Abstract On average young people "undersave" whereas old people "oversave" with respect to the rational expectations model of life-cycle consumption and savings. According to numerous studies on subjective survival beliefs, young people also "underestimate" whereas old people "overestimate" their objective survival chances on average. We take a structural behavioral economics approach to jointly address both empirical phenomena by embedding subjective survival beliefs that are consistent with these biases into a rank-dependent utility (RDU) model over life-cycle consumption. The resulting consumption behavior is dynamically inconsistent. Considering both naive and sophisticated RDU agents we show that within this framework underestimation of young age and overestimation of old age survival probabilities may (but need not) give rise to the joint occurrence of undersaving and oversaving. In contrast to this RDU model, the familiar quasi-hyperbol...

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Section: Discussionsupporting

confidence: 48%

Section: Introductionmentioning

confidence: 99%

The Impact of Biases in Survival Beliefs on Savings Behavior

2017

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“…One can see that bequest specifications with MPB greater than 0.9 can completely eliminate annuity demand when all other impediments to annuitization are present: bequest motives specified in Ameriks et al (2012) and Lockwood (2012b) Table 11: Annuity market participation rates for the full model with different parameterizations of bequest motives.…”

Section: Bequest Form Parameter Valuesmentioning

confidence: 99%

“…This suggests that disposable wealth is an important factor affecting the demand for annuities, especially if there is a restriction on the minimum amount that can be invested. 18 There is some heterogeneity in terms of how different impediments to annuitization affect people in different income quintiles. For the two bottom quintiles, illiquidity of housing wealth has the largest quantitative impact on the fraction of annuity market participants.…”

Section: Analyzing the Full Modelmentioning

confidence: 99%

Accounting for non-annuitization

Pashchenko

2013

Journal of Public Economics

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Why don't people buy annuities? Several explanations have been provided by the previous literature: large fraction of preannuitized wealth in retirees' portfolios; adverse selection; bequest motives; and medical expense uncertainty. This paper uses a quantitative model to assess the importance of these impediments to annuitization and also studies three newer explanations: government safety net in terms of means-tested transfers; illiquidity of housing wealth; and restrictions on minimum amount of investment in annuities. This paper shows that quantitatively four explanations play a big role in reducing annuity demand: preannuitized wealth, minimum annuity purchase requirement, illiquidity of housing wealth, and bequest motives. The annuity purchase involves big upfront investment, especially if there is a minimum purchase restriction. This is binding for many, especially if housing is illiquid and part of wealth is preannuitized. While bequest motives significantly reduce the overall annuity demand, the model with a strong bequest motive cannot match the empirical fact that high-income people have the highest demand for annuities.

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“…The latter of these explanations is even consistent with observed behaviors immediately prior to retirement (Brown and Previtero (2015)), but "there is little sharp evidence" that these preferences affect the household balance sheet (Zinman (2014)). To better understand why many retirees do not consume all of their assets, some have studied bequest motives (Bernheim et al (1985) and Hurd (1989)), as well as their interaction with wealth inequality (Nardi and Yang (2015)) and health (Lockwood (2014)). The advantage of our approach, relative to this literature, is that our findings can reconcile what appears to be contradictory behavior at opposite ends of the life-cycle.…”

Section: Introductionmentioning

confidence: 99%

YOLO: Mortality Beliefs and Household Finance Puzzles

Heimer

Myrseth²,

Schoenle³

2015

Working Paper (Federal Reserve Bank of Cleveland)

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Subjective mortality beliefs affect pre-and post-retirement consumption and savings decisions, as well as portfolio allocation. New survey evidence shows that individuals overestimate their mortality at short horizons and survival rate at long horizons. For example, a 28-year-old male with a 99.4% chance of surviving beyond 5 years believes he will do so with 92.8% probability. A 68 year old with a 71.4% probability of living to 78 believes he has an 82.4% chance of living that long. The formation of these beliefs across age cohorts can be attributed to overweighting salient causes-of-death. This bias matters empirically: Survival expectations correlate with heterogeneity in fi nancial education and investment behavior. Embedded in a run-of-the-mill life-cycle model, these beliefs cause the young to under-save and retirees to not fully draw down their assets. In addition, for reasonable levels of risk-tolerance, the required excess rate of return on equity is in line with historical averages once subjective beliefs are accounted for.

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Incidental Bequests and the Choice to Self-Insure Late-Life Risks

Cited by 96 publications

References 60 publications

The Impact of Biases in Survival Beliefs on Savings Behavior

The Impact of Biases in Survival Beliefs on Savings Behavior

Accounting for non-annuitization

YOLO: Mortality Beliefs and Household Finance Puzzles

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